Explanation: This is called the Actual Cash Value (ACV) or Actual Cost Valuation (ACV)
All of the other answers were only detractors. Below you have an explanation of the different types of valuation you could use. It is VERY important for you to validate with your insurer which one applies to you as you could have some very surprising finding the day you have a disaster that takes place.
Replacement Cost
Property replacement cost insurance promises to replace old with new. Generally, replacement of a building must be done on the same premises and used for the same purpose, using materials comparable to the quality of the materials in the damaged or destroyed property.
There are some other limitations to this promise. For example, the cost of repairs or replacement for buildings
doesn’t include the increased cost associated with building codes or other laws controlling how buildings must be built today. An endorsement adding coverage for the operation of Building Codes and the increased costs associated with complying with them is available separately — usually for additional premium.
In addition, some insurance underwriters will only cover certain property on a depreciated value (actual cash value — ACV) basis even when attached to the building. This includes awnings and floor coverings, appliances for refrigerating, ventilating, cooking, dishwashing, and laundering. Depreciated value also applies to outdoor equipment or furniture.
Actual Cash Value (ACV)
The ACV is the default valuation clause for commercial property insurance. It is also known as depreciated value, but this is not the same as accounting depreciated value. The actual cash value is determined by first calculating the replacement value of the property. The next step involves estimating the amount to be subtracted, which reflects the
building’s age, wear, and tear.
This amount deducted from the replacement value is known as depreciation. The amount of depreciation is reduced by inflation (increased cost of replacing the property); regular maintenance; and repair (new roofs, new electrical systems, etc.) because these factors reduce the effective age of the buildings.
The amount of depreciation applicable is somewhat subjective and certainly subject to negotiation. In fact, there is often disagreement and a degree of uncertainty over the amount of depreciation applicable to a particular building.
Given this reality, property owners should not leave the determination of depreciation to chance or wait until suffering
a property loss to be concerned about it. Every three to five years, property owners should obtain a professional appraisal of the replacement value and depreciated value of the buildings.
The ACV valuation is an option for directors to consider when certain buildings are in need of repair, or budget constraints prevent insuring all of your facilities on a replacement cost basis. There are other valuation options for property owners to consider as well.
Functional Replacement Cost
This valuation method has been available for some time but has not been widely used. It is beginning to show up on property insurance policies imposed by underwriters with concerns about older, buildings. It can also be used for buildings, which are functionally obsolete.
This method provides for the replacement of a building with similar property that performs the same function, using less costly material. The endorsement includes coverage for building codes automatically.
In the event of a loss, the insurance company pays the smallest of four payment options.
1. In the event of a total loss, the insurer could pay the limit of insurance on the building or the cost to replace the building on the same (or different) site with a payment that is “functionally equivalent.”
2. In the event of a partial loss, the insurance company could pay the cost to repair or replace the damaged portion in the same architectural style with less costly material (if available).
3. The insurance company could also pay the amount actually spent to demolish the undamaged portion of the building and clear the site if necessary.
4. The fourth payment option is to pay the amount actually spent to repair, or replace the building using less costly materials, if available (Hillman and McCracken 1997).
Unlike the replacement cost valuation method, which excluded certain fixtures and personal property used to service the premises, this endorsement provides functional replacement cost coverage for these items (awnings, floor coverings, appliances, etc.) (Hillman nd McCracken 1997).
As in the standard replacement cost value option, the insured can elect not to repair or replace the property. Under these circumstances the company pays the smallest of the following:
1. The Limit of Liability
2. The “market value” (not including the value of the land) at the time of the loss. The endorsement defines “market value” as the price which the property might be expected to realize if ffered for sale in fair market.”
3. A modified form of ACV (the amount to repair or replace on he same site with less costly material and in the same architectural tyle, less depreciation) (Hillman and McCracken 1997).
Agreed Value or Agreed Amount
Agreed value or agreed amount is not a valuation method. Instead, his term refers to a waiver of the coinsurance clause in the property insurance policy. Availability of this coverage feature varies among insurers but, it is usually available only when the underwriter has proof (an independent appraisal, or compliance with an insurance company valuation model) of the value of your property.
When do I get paid?
Generally, the insurance company will not pay a replacement cost settlement until the property that was damaged or destroyed is actually repaired or replaced as soon as reasonably possible after the loss.
Under no circumstances will the insurance company pay more than your limit of insurance or more than the actual amount you spend to repair or replace the damaged property if this amount is less than the limit of insurance.
Replacement cost insurance terms give the insured the option of settling the loss on an ACV basis. This option may be exercised if you don’t plan to replace the building or if you are faced with a significant coinsurance penalty on a replacement cost settlement.
References:
http://www.schirickinsurance.com/resources/value2005.pdf
and
TIPTON, Harold F. & KRAUSE, MICKI
Information Security Management Handbook, 4th Edition, Volume 1
Property Insurance overview, Page 587.
